For two years, a group of American public finance experts has been
engaged in an advisory role related to the establishment of a new public
finance system as part of the evolution of the new structures and new
governments succeeding the USSR. These activities have been organized
through a nonprofit, United States corporation known as EcoLink.

Obviously, there has been a problem in maintaining a clear
definition over this period of time with respect to the governments that
would employ the new structures. For the sake of convenience, the
author uses the term, Soviet Union, in this article to mean both the
central government and the geographic area that existed in the USSR
prior to the most recent separation by several republics.

Of course, the dominant economic and governmental area for many
centuries, including the period of Soviet rule, has been Russia itself.
While it is possible that the new public finance structure will be
employed by the future central government that may exist as a
confederation or similar form of government, loosely tying several
republics together, the projects on which the new public finance system
will be based and for which EcoLink has been involved consists of
project financings to be employed for public projects within the
Republic of Russia, and with a possible extension to peripheral
republics. Therefore, the program that will be discussed herafter
should be seen in the context of the Republic of Russia, for
clarification purposes.

Representatives of EcoLink have made approximately 15 trips to the
Soviet Union in support of demonstration projects on which the future
public finance system will be based. Initially, the central government
provided the impetus and counterparties to the American group.
Gradually, local and republic representatives there have become more
directly involved.

Bond Issuance in the Soviet Union

Prior to the 1917 revolution, the use of bonds within Russia was
quite extensive with various types of commercial activities, such as
railroads, raising capital both domestically and on the international
marakets. In addition, the Russian government had sold a significant
amount of bonds, the so-called Czarist Bonds, prior to 1917. Of course,
after the Bolsheviks gained power, the responsibility to make payment on
these obligations was abrogated.

The Soviet government used bonds for various purposes during the 70
years of its existence. For example, in 1922, government bonds were
issued to farmers as a form of payment for the requisition of
agricultural goods; farmers were required to exchange food stuffs for a
bond which entitled them to a payment for goods within 10 years.

The Soviet government in the 1920s and 1930s issued bonds to help
redistribute funds among state-owned enterprises by taking funds from
enterprises that had excess rubles to subsidize those activities that
were in a deficit ruble position. During Stalin's tenure in the
1930s, the government issued large quantities of 20-year bonds that
yielded no interest and were developed as a way of fighting inflation,
as a result of severe shortage of goods. During World War II, 20-year
war bonds were issued as a way of paying for the war, and individuals
were required to purchase their proportionate share of the bonds. At
maturity date, after Stalin's death, Khrushchev then delayed the
payment of the bonds for another 20 years, but at the subsequent
maturity date, President Breshnev paid the principal to all bondholders.
Since interest payments were not made, the value of the bond repayment
was, at best, minimal.

Later, other forms of bonds surfaced, such as a "lottery
bond" and a "commodity bond." These programs were not
popular, lacked the confidence of investors and citizens, and eventually
were eliminated.

Recently, with Soviet budget deficits exceeding 10 percent of GNP,
the Soviet government decided to sell more than 75 billion rubles worth
of long-term bonds to institutional and individual investors. The new
bonds paid 5 percent interest, had coupons attached, a call feature and
a maturity of 16 years. The bonds were backed by the central government
and by the State Bank of the USSR and were distributed by savings bank branches. The bonds sold miserably because the low interest rate was
well below the inflation rate of 10 percent or more. As a result, the
government raised the interest on the certificates for individuals to 10
percent, which allowed the bonds to be sold more effectively.

The experience of the Soviet system in honoring its debt
obligations has again been brought into question as a proposal has been
made, and apparently agreed upon, for the external Soviet debt to be
restructured by the international holders so that financial and
budgetary pressures for the central government can be alleviated. The
decision for the government to restructure existing debt has been a
highly controversial proposal, both domestically and internationally,
since the amount of debt is relatively modest, substantially less than
$100 billion, and indicates to the world financial community an
evaporating commitment of the government to honor obligations that had
very recently been made to the international financial community.

Notwithstanding the internal and external controversy surrounding
the decision to restructure the current, external Soviet debt, it should
be emphasized that by any standard, the financial stability of the
central government has deteriorated dramatically. For example, the
Soviets measure the flexibility and fundamental strength of their
financial system by comparing "money stock" against their
commodity reserve. A loose analog of such an index at the municipal
level in the United States is the relationship between general fund
expenditures and the government's fund equity position. Soviet
money stock consists principally of bank deposits and presumed cash on
hand. This amount is measured against a commodity reserve which
consists of the government's inventory of saleable commodities.
Recently, there has been a precipitous and absolute decline in the
relationship between money stock and commodity reserve. The 1991 figure
is less than one-half that in 1985 and is less than one-quarter of the
figure that existed in 1970. This fact is obviously significant when
judging the rationale for restructuring external Soviet debt.

Economic Reform

One of the most surprising aspects of EcoLink's participation
has been the attention paid to public finance by the central government,
the Republic of Russia and local government officials. Virtually every
major official involved with economic reform policy has given individual
attention to the development of the new public finance system, as
proposed by EcoLink, and many have been instrumental in creating the
environment for governmental and economic reform for the Soviet Union.

The primary reason for the interest has been twofold. First, the
physical facilities previously have been funded principally by the
central government from current operating outlays. With dwindling resources and competing demands for the remaining budgetary outlays, the
ability to spread out these payments for physical facilities over a
longer period of time through the use of long-term bonds is especially
attractive. Second, inflation can undermine the prospects for economic
reform. if investment can be made by individuals and enterprises in an
amount that decreases the substantial overlay of nonproductive ruble
inventory, then the dangers of hyper-inflation and more social
instability has been mitigated. Because of the key ingredients that
these two factors represent for the success of economic reform, public
finance continues to be an attractive option for government officials.

Many American public finance experts have argued that the
international financial community will be the most effective source of
funding for capital expenditures in the areas that formerly consisted of
the Soviet Union. They state that the internal sources of capital are
limited and less inclined for investment than sources at the
international level. It is very difficult, if not impossible, to argue
against this position. Nevertheless, from an economic reform
perspective, external funding of public finance projects does not
directly attack the problems that have been identified. For example,
external funding may reduce the amount of current expenditures that will
be applied to capital projects, but it does nothing to eliminate the
ruble reservoir that can contribute to hyper-inflation.

It also should be noted that public finance, as an alternative, is
of increasing importance to government officials at the republic and
local levels as well. Republic and local officials have begun to
recognize that the use of an internal bond market for the financing of
large-scale capital expenditures can reduce the budgetary pressures that
will exist for independent governments.

Projects to be Financed

At the beginning of the endeavor, three projects were selected to
demonstrate the important role that a new public finance system could
provide to the economic reform movement being established and
implemented by the central government in late 1989 and through much of
1990. These projects consisted of an AIDS hospital, and industrial
complex that produced goods and services for which limited "hard
currency" had previously been used to buy such goods and services
on the international market, and the financing of a series of stock
exchanges. Subsequently, the latter project became inappropriate, as
the stock and commodity exchanges became so popular and lucrative that
the facilities were financed by the exchanges themselves.

Over the two years that EcoLink has been involved in the
establishment of a new public finance system in the former USSR, the
projects have become more definitive. For example, because the Soviet
government has historically employed a large amount of its precious hard
currency reserves to buy grain in international market, the capacity to
increase its grain storage facilities represents a pressing requirement.
The immediate advantage that new grain storage facilities can provide
produces a return by preserving hard currently reserves. Indeed, the
economic value of new grain storage facilities will allow the debt
incurred for this purpose to be repaid within two years of amortization
will apply in order to reduce financial pressures.

The project that has been given most attention has been the AIDS
hospital planned for construction in the City of Moscow. The medical
records compiled by the Soviet government have been perceived for many
years as being very suspect. For example, in early 1991, the Soviets
apparently reported to the World Health Organization that the country
had only 48 cases of AIDs. According to our extensive discussions over
the two years with credible health officials, the number of persons in
the former USSR who were HIV positive equalled approximately three
million people, or, on a comparable basis, a higher level than exists in
the United States.

Proposed General Bond Structure

For the AIDS hospital and series of grain storage facilities, there
will be different, but similar financing structures.

A series of recommendations has been considered for the AIDS
hospital. One scenario has repeatedly been endorsed. Reflecting this
scenario, an operating agreement was signed earlier this year among the
City of Moscow, Republic of Russia and All-Union Government. In this
agreement, it was anticipated that the City of Moscow would issue the
equivalent of general obligation bonds in an amount approximating $110
million in hard currency dollars for the funding and construction of the
AIDS hospital to be located in Moscow. In turn, debt service on these
obligations would be paid through a combination of reimbursements by the
Republic of Russia and the All-Union Government. Because of the major
adjustments that have occurred with the increasing importance of
republican governance, the role of the Republic of Russia has steadily
increased. For example, two years ago, the All-Union Government would
have been responsible for making virtually all capital reimbursement payments which would pay for debt service for the AIDS hospital.
Steadily, the Republic of Russia has increased its budgetary importance,
and Russia presumably now will be the primary source of reimbursement
for the AIDS hospital financing.

For the series of grain storage facilities, they will be located in
and about the Republic of Russia, and the Republic itself is expected to
issue debt, on a project financing basis. In turn, the money saved as a
result of a decrease in the use of hard currency for the purchase of
grain will be employed for the payment of debt service on bonds.

While both project financing are expected to enjoy specific related
revenues in an amount sufficient to secure the bonds that will be sold,
the uncertainty and novelty surrounding these project financings will
make it essential for some form of general purpose government support to
be applied to the bonds.

Moreover, the maturity for the bonds to be issued for the AIDS
hospital will be longer than those issued for the grain storage
facilities. Because of the immediate financial return available from
the grain storage facilities, the maturity on those securities will be
quite short, possibly no more than five years. At the same time, based
on research and advice from counterparts, it is the consensus that the
maturity for the debt obligations to be sold for the

AIDS hospital should not extend beyond 10 to 12 years. While such a
short maturity for a hospital would not be suitable in the U.S. domestic
public finance market, since the capital reimbursement portion would be
substantial and onerous, the use of a maturity structure of 10 to 12
years still will provide budgetary relief there, since normally a
facility of the kind for the AIDS hospital would have been paid out of
current revenues by the central government.

Distribution of the proposed bonds will be accomplished through a
network arranged by existing banks, including savings banks. A question
has arisen regarding the prospects for selling the debt for the initial
projects to retail purchasers. EcoLink has advised that such an
arrangement would create extensive complexity, and therefore, for the
initial projects, commercial and savings banks, enterprises with excess
rubles and the equivalent to our pension funds are the targeted
investors for these projects.

As a short vignette based on discussions with one of the
enterprises demonstrates, the change in attitude toward privatization has occurred in a very short period of time. A newly created
enterprise, through new legislation, created a board to govern. A
former, high-level Communist party official had been appointed to the
board. Pursuant to the legislation, the board was authorized to invite
a member of the labor union that worked for the enterprise to serve on
the board. In the midst of talks about the possibility that the
enterprise would invest in public finance bonds, the discussion was
interrupted by board consideration as to the possible addition of the
labor union official. The former Communist party official was quite
adamant that the labor union representative should not sit on the board
for reasons that the labor union representative would not be sensitive
to the need for optimizing profits and earnings for the enterprise.
EcoLink representatives considered this quintessential irony and
reflective of new institutional struggles.

While considering the prospective role that a trustee would provide
in the context of the envisioned project financings, the issue of
registration became critical for the Russians. It was their belief that
bearer bond securities will not be politically acceptable to the
citizens since so much attention has been paid by government officials
and the populace at large to the need for control of black market
profits. There has been fear that the use of bearer bonds will be a
means by which profits from black market and underground sources can be
laundered.

It should be emphasized at this point that a market economy is not
expected to create the economic disparity in the former USSR that
currently exists in Western nations among economic classes. Many in the
Western world expect that the people of these republics will eventually
become mirror images of Westerners. The attitudes and information
received by EcoLink would suggest otherwise. A social contract that
will limit the disparity among economic classes will continue to exist
much more effectively than exists in the Western world.

Finally, as described above, the funds for these projects will be
raised internally to establish a precedent on which future public
finance projects can be accomplished without access to foreign markets.

Many Western observers have expressed the idea that there will be
ready adaptation to the systematic checks and balances that exist in the
Western debt issuance system. This conclusion does not reflect a
realistic knowledge of the practices that have recently been put into
place in former USSR for the privatization of securities' issuance.
For example, at present, there is much less sensitivity and deference
paid to potential conflicts of interst as privatization evolves out of
the massive, centralized government that previously existed. Witness
the chairman and chief executive officer of the Russian Commodity, Raw
Material and Stock Exchange in Moscow, who is also chairman of the board
of the Russian National Bank. This bank provides the equivalent of a
line of credit and cash for brokers on the exchange to carry their
positions, in effect, an arrangement that would be equivalent to the
chairman of the New York Stock Exchange serving as chairman of a bank
that had the monopolistic ability to provide banking services for
brokerage firms that are active on the NYSE. The potential for conflict
of interest of this type would not be tolerated in the American business
environment. However, as the privatization momentum continues there, it
is obvious that similar conflicts of interest will occur until a system
with greater safeguards exists.

Investors in Moscow already have experienced a scandal in the
financial markets. There have been no advertising prohibitions over the
past 18 months that have limited the ability of companies offering stock
for new enterprises and other private ventures. Indeed, one company did
offer investment opportunities by extensive advertisement, and many
Moscovites did, in fact, invest in the company. There was a
mini-scandal about the proper management of the investment company when
a large number of investors lost funds they had contributed. One does
worry that the current environment, with the absence of appropriate
checks on the activities of many new entrepreneurs, will create
opportunities for securities fraud and manipulation as the momentum for
privatization accelerates.

The Advisory Process

Participation by EcoLink in the emergence of a new public finance
system has its roots in developments that occurred several years ago.
Dr. Jeffrey A. Sachs, while he served as chief of staff for a
congressman, attended an international conference in Stockholm where he
had the opportunity to meet with certain Soviet officials involved in
the reform process then operative in the USSR. Subsequent to these
meetings, Dr. Sachs made several trips to Moscow and met with
individuals deeply engaged in the economic reform movement there. These
discussions resulte in protocol being signed in the fall of 1989 among
the Commissioin on Economic Reform, the Institute for USA and Canada,
and Dr. Sachs.

Dr. Sachs assembled a number of public finance experts to
participate in implementation of the terms of the protocol, which, in
part, established the goal of creating a new public finance system
within the USSR. To codify the American advisory efforts, EcoLink was
created as a nonprofit corporation in early 1990. To symbolize the role
that EcoLink would provide to the new emerging economic environment in
the Soviet Union, it was requested and EcoLink agreed to hold its first
Board of Director's meeting at the offices of the Institute of the
USA and Canada in Moscow on April 12, 1990.

During the first few months of 1990, numerous meetings were held in
Moscow and in the United States to further refine the process by which
the new public finance system could be established. In April, a new
agreement was signed to implement the next steps toward this goal. An
additional agreement was reached at that time and represented the first
time that an individual American corporation had been a signatory to an
agreement evidenced on Kremlin documents over the 70 years of Communist
rule.

As part of the agreement, EcoLink was authorized to issue a request
for proposals in the United States to investment banking firms and bond
counsel firms to provide the necessary support to conclude the
envisioned project financings. These requests for proposals were
published in early summer 1990, in The Wall Street Journal and The New
York Times. Nearly 100 responses were received from investment banking
and financial advisory firms from U.S. and foreign-based companies.
Five firms were selected. A list of law firms was developed,
representing the largest and most active bond counsel firms in the
American public finance field. This group of firms has been available
to provide appropriate legal assistance to the endeavor.

In early 1991, a series of critical meetings were held in Moscow
and a preliminary program for the funding of the AIDS hospital and grain
storage facilities was prepared and structured with the following
elements.

* For the AIDS hospital, the City of Moscow would issue debt as
general obligation bonds, with debt service supported by a capital
reimbursement from the All-Union Government and the Republic of Russia.
The proceeds of the bond sale would replenish advance payments by the
Ministry of Finance, which wished to move quickly to construct the
facility. While the financing would be accomplished through the sale of
securities internally, materials and certain expertise would be
purchased on the international market through the hard currency advance.
It should be emphasized that the normal period for hospital construction
in the USSR is eight to 10 years, but through the use of hard currency
purchases and a streamlined approval process, it was expected that the
AIDS hospital could be opened within three years after funds were made
available.

* For the series of grain storage facilities, the Republic of
Russia would issue debt. The savings of hard currency reservers, by
virtue of not having to buy grain on the open market, would be
sufficient to repay the borrowed funds.

A series of meetings also was held with the state bank of the USSR,
which had agreed to serve as both trustee and as principal distributor
of the securities for the program. At the time when the initial
structures were agreed upon--in early 1991--both sides expected that the
financing would be accomplished by late summer 1991, and all parties
worked independently for several months to develop the appropriate
approaches and refinements for the funding of these two projects.
Nonetheless, considerable political instability began to arise at the
time culminating in the attemptd coup during the summer, which would
presumably have eliminated further progress on economic reform of which
the new public finance system and the demonstration projects were an
important part.

Obstacles To Be Faced

An enormous amount of effort and expense has been incurred on both
sides to accomplish the envisioned goal. The good will shown on both
sides has been exceptional, and members of the working group for both
sides are certain that the transactions will occur in the near future.

The principal obstacle that faces the full implementation of the
program lies with the uncertain institutional and political climate
existing in the areas that formerly constituted the USSR. In that
respect, however, it is important to note that the AIDS hospital
agreement has three signatories: the USSR, the Republic of Russia and
the City of Moscow.

The educational process has been completed, and the benefits of the
public finance system have become obvious. At the same time, the
demands on resources over the next several months, particularly if food
shortages and a severe winter are experienced, the technical advantages
of long-term benefits derivative of the new public finance system will
be much less important, as more critical political and governance issues
are faced. In that set of circumstances, it will be increasingly
difficult to receive the necessary commitments and attention of leaders
who have been very supportive of the new public finance system through
their principal advisors, as an ingredient to economic reform. As 1992
begins, EcoLink continues to work with the Republic of Russia, and as
recently as early December 1991, representatives of the group were in
Moscow meeting with officials of the Republic of Russia and the City of
Moscow on the demonstration public finance projects.

J. CHESTER JOHNSON, president of Government Finance Associates,
Inc., a leading independent public financial advisory firm, is a member
of the Board of Directors and senior financial advisor to EcoLink. He
is the 1988 recipient of the Distinguished Lifetime Contributions Award
for Municipal Analysis, presented by the National Federation of
Municipal Analysts.

COPYRIGHT 1992 Government Finance Officers Association
No portion of this article can be reproduced without the express written permission from the copyright holder.